New HUD Rulemaking May Mark Increased Use of Disparate Impact Test in Analysis of Discrimination Under the Fair Housing Act

On June 25, 2021, the US Department of Housing and Urban Development (HUD) published in the Federal Register a notice of proposed rulemaking (NPRM) proposing to rescind a 2020 HUD rule that expanded requirements for the use of discriminatory effects, also referred to as “disparate impact,” in determining whether discrimination prohibited by the Fair Housing Act (FHA) has occurred.¹ The NPRM also proposes to restore a discriminatory effects rule adopted by HUD in 2013 that formalized the application of discriminatory effects in assessing potential discrimination. Although it has a long history, discriminatory effects, or disparate impact, analysis has been given varying weight over the years, and the return of the 2013 rule indicates increased support for the test, which allows the finding of discriminatory conduct even in the absence of evidence of intentional discrimination. Accordingly, organizations may need to pay closer attention to the effects of their policies than was the case during the previous administration.

The theory of disparate impact liability was well established even before the 2013 HUD rule. Not only HUD, but also the federal banking agencies, the Consumer Financial Protection Bureau and the US Department of Justice have relied on disparate impact liability under the Equal Credit Opportunity Act and its implementing Regulation B, as well as the FHA. The 2013 rule represented a codification of the disparate impact/discriminatory effects standard designed to encourage and facilitate its application. The 2013 rule sets out a three-pronged test: (1) a policy, even one that is neutral on its face, has a discriminatory effect when it actually or predictably results in disparate impact on a group of persons or creates, increases, reinforces, or perpetuates segregated housing patterns because of race, color, religion, sex, handicap, familial status or national origin, unless (2) the policy is necessary to achieve one or more substantial, legitimate, nondiscriminatory interests and (3) those interests could not be served by another practice that has a less discriminatory effect.²

The 2013 rule further states that proof that the discrimination was not unlawful must be supported by evidence and not be hypothetical or speculative. Finally, the rule states the burden of proving that a challenged practice has a discriminatory effect is on the claimant, at which point the burden of showing a legitimate nondiscriminatory purpose shifts to the respondent or defendant. If the respondent satisfies this burden, then the burden of proving that there is an alternative practice with a less discriminatory effect passes back to the claimant.³

In 2015, in Texas Department of Housing and Community Affairs v. Inclusive Communities Project, Inc. (ICP), the US Supreme Court held that disparate impact claims are cognizable under the FHA.⁴ Although the Supreme Court referenced the 2013 HUD rule, the Court undertook its own analysis of disparate impact, including providing guidance that a disparate impact claim that relies on a statistical disparity must fail if the plaintiff cannot point to a defendant’s policy or policies causing the disparity, and that racial imbalance, without more, does not establish a prima facie case of disparate impact.

In 2019, HUD, which had previously sought comment on the disparate impact rule,⁵ issued a proposed rule to replace the disparate impact standard in the 2013 rule.⁶ HUD adopted a final rule in September 2020.⁷ In releases of both the proposed and final rule, HUD stated that it was implementing the limitations on the disparate impact rule contained in the ICP decision;⁸ however, critics have alleged that the limitations in the 2020 rule go beyond what the Supreme Court intended in ICP.

The 2020 rule replaced the 2013 three-prong test with a five-prong test requiring a plaintiff to sufficiently plead facts to support each of the following elements:

(1) That the challenged policy or practice is arbitrary, artificial, and unnecessary to achieve a valid interest or legitimate objective such as a practical business, profit, policy consideration, or requirement of law;

(2) That the challenged policy or practice has a disproportionately adverse effect on members of a protected class;

(3) That there is a robust causal link between the challenged policy or practice and the adverse effect on members of a protected class, meaning that the specific policy or practice is the direct cause of the discriminatory effect;

(4) That the alleged disparity caused by the policy or practice is significant; and

(5) That there is a direct relation between the injury asserted and the injurious conduct alleged.⁹

The 2020 rule provides more detail than the 2013 rule on a plaintiff’s burden of proof to establish that a policy or practice has a discriminatory effect, and it also adds a list of defenses available to a defendant in a discriminatory effects case.¹⁰

The 2020 rule was supposed to become effective on October 26, 2020; however, its implementation was enjoined prior to that date and it has never gone into effect.¹¹ Although HUD will accept comments on the NPRM through June 24, 2021, it seems likely that the 2020 rule will be rescinded and the 2013 rule will be reinstated, particularly since the Biden Administration issued a Memorandum in January 2021 specifically directing HUD to reconsider the 2020 rule.¹²

As a legal matter, the 2013 rule has continued in effect despite the effort to rescind it. As a practical matter, however, some organizations may have become less concerned about disparate impact risks during the Trump Administration. In any case, the present situation calls for either renewed or continuing attention to these risks. This attention can include:

(1) Internal audits: Internal testing of a wide range of policies and practices that are race-neutral in intent but could have a disparate impact along racial lines. Organizations should be proactive in identifying areas of susceptibility to statistical challenge. One of the most reliable methods of doing so is to conduct routine statistical self-assessments on a portfolio-wide basis, appropriately structured to ensure the attorney-client privilege will apply. Organizations should conduct periodic assessments, analyze the results (including file reviews of any outliers) and tailor policies and procedures in accordance with such results, to ensure that the organization is alert to potential disparities and can address any fair lending-related issues before they become supervisory concerns.

(2) Policies and procedures: Organizations should carefully review their policies and procedures to identify instances in which discretion is permitted in any aspect of underwriting or other credit processes, as discretion can potentially give rise to discriminatory results. To the extent policies and procedures allow for discretion or exceptions, organizations should build into their corporate governance structure mechanisms to approve such exceptions or departures from common practice, and record keeping procedures to ensure proper documentation. In effect, the organization is creating a record of why a departure from normal business practices was made and the reasons for that decision. The exceptions should also be monitored to ensure that they are being made consistently across the organization. To the extent the organization considers any changes to its policies and procedures as a result of its review, senior management should articulate the business-related or risk-related reasons why such changes were or were not made. In addition, organizations should identify any policies that create statistical disparities and consider whether there are alternative policies or procedures (or modifications to existing policies and procedures) that address the same credit concerns but that do not have the same impact or have less of a disparate impact.

(3) Corporate governance and documentation: In light of legal and regulatory concerns about fair lending, any business decisions that may involve practices that could have a disparate impact on a protected class, such as changing or discontinuing a particular product or service, should be carefully considered, and the justifications for them should be clearly documented. Organizations should establish corporate governance procedures that provide for review of material changes to product and services offerings by senior management and fair lending/risk committees. The results of the review, including assessments of the reasons for the business decisions at issue, should be documented through meeting minutes and other records.

HUD’s reinstatement of its 2013 disparate impact rule is both consistent with and an example of increasing focus on consumer rights and equal treatment under the law. Organizations that mirror this focus in their operations, including taking the types of action described in this advisory, will have an advantage doing business in the current environment.

© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.