The Burden-Shifting Framework in Disparate Impact Cases: The Inclusive Communities Decision and HUD’s Disparate Impact Regulation

HousingIntroduction

In a recent decision, the U.S. Supreme Court held that disparate impact claims are cognizable under the Fair Housing Act, (“FHA”), 42 U.S.C. § 3601 et seq. See Texas Department of Housing & Community Affairs v. Inclusive Communities Project, Inc., 576 U.S. ___, 2015 WL 2473449 (Jun. 25, 2015). The specific issue on appeal in Inclusive Communities was whether Congress intended the FHA to open the door to disparate impact litigation, and the Court answered that question in the affirmative.

While the Inclusive Communities appeal was pending, the Department of Housing Development (“HUD”) promulgated a regulation, codified at 24 C.F.R. § 100.500, that discusses the burden-shifting framework applicable to disparate impact litigation under the FHA. In the Inclusive Communities decision, the Supreme Court went beyond the narrow question on appeal and commented on this burden-shifting framework. One of the challenging questions raised by the decision is whether these aspects of the Supreme Court’s decision have effectively supplanted, in whole or in part, the HUD regulation.

As discussed below, the Supreme Court’s decision in many respects comports with, and elaborates on, the HUD regulation. At the same time, while the regulation indicates that, once a plaintiff has established a prima face disparate impact case, the defendant must show that the alleged disparate impact is justified by “substantial, legitimate, nondiscriminatory interests,” the Inclusive Communities decision describes the defendant’s burden in different terms, namely that the defendant must point to a “valid interest” justifying the alleged disparate impact. The phrase “valid interest” could be interpreted as suggesting a less demanding burden, and in this sense the Inclusive Communities decision is helpful to defendants.

Summary of the Inclusive Communities Decision

The dispute in Inclusive Communities involved the distribution of federal low-income housing tax credits, with the plaintiff, the Inclusive Communities Project, Inc. (“ICP”), alleging that credits had been distributed in a discriminatory manner by the Texas Department of Housing and Community Affairs (the “Department”). Inclusive Cmtys., 2015 WL 2473449, at *4. The ICP asserted that credits had been approved by the Department in a way that perpetuated racial segregation in violation of the FHA. Id.

The District Court ruled in favor of ICP, reasoning that ICP had proven a prima facie disparate impact case, and that “the Department ‘failed to meet [its] burden of proving that there are no less discriminatory alternatives’” for allocating the tax credits. Id. The Fifth Circuit Court of Appeals reversed that decision and remanded the case because, the Fifth Circuit held, the District Court had improperly placed on the defendant, rather than the plaintiff, the burden of proving that less discriminatory alternatives exist. Id.

Subsequent to the Fifth Circuit’s decision, the Supreme Court took up the specific question of whether, as a categorical matter, disparate impact litigation is consistent with the language and intent of the FHA. As the Court noted, “[i]n contrast to a disparate-treatment case, where a ‘plaintiff must establish that the defendant had a discriminatory intent or motive,’ a plaintiff bringing a disparate-impact claim challenges practices that have a ‘disproportionately adverse effect on minorities’ and are otherwise unjustified by a legitimate rationale.” Inclusive Cmtys., 2015 WL 2473449, at *3.

The Court determined that the FHA indeed contemplates disparate impact litigation. This aspect of the Court’s decision was consistent with the holding of every Court of Appeal that previously had addressed this issue, as well as the existing policy of HUD, and thus does not represent a significant change in the status quo of the law.

The HUD Regulation

The HUD regulation, in addition to expressing HUD’s position that a policy or practice that creates a disparate impact claim may potentially constitute unlawful discrimination under the FHA, also sets forth HUD’s view regarding how a plaintiff would go about proving a disparate impact claim in a civil action. This burden-shifting framework is substantially similar to the framework used by many federal courts of appeal.

First, the plaintiff must prove that the policy or practice at issue “caused or predictably will cause a discriminatory effect.” See 24 C.F.R. § 100.500(c)(1). In the regulation, a “discriminatory effect” is defined as a policy or practice that “actually or predictably results in a 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.” See 24 C.F.R. § 100.500(a).

Second, if the plaintiff satisfies the above-referenced burden, “the respondent or defendant has the burden of proving that the challenged practice is necessary to achieve one or more substantial, legitimate, nondiscriminatory interests of the respondent or defendant.” See 24 C.F.R. § 100.500(c)(2). Such a justification “must be supported by evidence and may not be hypothetical or speculative.” See 24 C.F.R. § 100.500(b)(2).

Third, if the defendant establishes such a justification, the burden of proof shifts back to the plaintiff. See 24 C.F.R. § 100.500(c)(3). At this point, the plaintiff must show “that the substantial, legitimate, nondiscriminatory interests supporting the challenged practice could be served by another practice that has a less discriminatory effect.” Id. If the plaintiff cannot make this showing, the disparate impact claim must be dismissed. Id.

The Interplay Between the HUD Regulation and the Inclusive Communities Decision

To the extent the Supreme Court’s decision in the Inclusive Communities case touched on the burden-shifting framework that governs disparate impact cases under the FHA, the decision was in some respects consistent with the HUD regulation, but in other respects employed language that differs from that found in the regulation.

The First Step

Regarding the first step in the three-step framework, the Court implicitly concurred with HUD that the plaintiff in a disparate impact case bears the initial burden of persuasion, and the Court elaborated on the nature of this burden. The Court held that a mere “showing of a statistical disparity” is insufficient, as the purpose of disparate impact litigation is not to impose “racial quotas.” Inclusive Cmtys., 2015 WL 2473449, at *2. The plaintiff must show that a statistical disparity was caused by the defendant’s policies or practices, as opposed to extrinsic factors beyond the defendant’s control. Id. at *14.

Further elaborating on the first step, the Court suggested that, to the extent an alleged disparate impact was a function of the defendant’s compliance with applicable laws and regulations, a disparate impact claim should fail. As the Court held, the FHA “does not put housing authorities and private developers in a double bind of liability, subject to suit whether they choose to rejuvenate a city core or to promote new low-income housing in suburban communities.” Inclusive Cmtys., 2015 WL 2473449, at *14.

For example, the Court suggested – but was careful not to predetermine – that, on remand, ICP’s disparate impact claim “may be seen simply as an attempt to second-guess which of two reasonable approaches a housing authority should follow in the sound exercise of its discretion in allocating tax credits for low-income housing.” Inclusive Cmtys., 2015 WL 2473449, at *13. After all, the Court noted, “it seems difficult to say as a general matter that a decision to build low-income housing in a blighted inner-city neighborhood instead of a suburb is discriminatory, or vice versa.” Id. at *15.

As an additional illustration of this point, the Court made reference to the Magner case, an earlier disparate impact case that was appealed to the Supreme Court but subsequently settled. In Magner, a city ordinance required landlords to improve conditions in apartment buildings, yet the plaintiffs in the Magner case claimed that landlords’ compliance with this ordinance created an unlawful disparate impact as the costs of compliance were passed on to minority tenants of these buildings. In the Inclusive Communities decision, the Court implied that the Magner claim was improper, noting that the claim was not reviewed under “the cautionary standards announced in this opinion.” Inclusive Cmtys., 2015 WL 2473449, at *15.

The Second Step

Regarding the second step in the burden-shifting framework, the Inclusive Communities decision does not use the language of the HUD regulation. While the Court noted its awareness of the regulation, the Court chose not to quote the regulation when describing the nature of the defendant’s burden in a disparate impact case. The HUD regulation, as discussed above, refers to “substantial, legitimate, nondiscriminatory interests of the respondent or defendant.” See 24 C.F.R. § 100.500(c)(2). Instead of using that language, the Court held that a defendant may defeat a disparate impact claim by pointing to a “valid interest served” by the policy or practice at issue, and by showing that such policy or practice is “necessary to achieve [that] valid interest.” Inclusive Cmtys., 2015 WL 2473449, at *14.

The Court further noted that “practical business choices and profit-related decisions” may constitute valid interests, just as, in the Title VII context, “an employer may maintain a workplace requirement that causes a disparate impact if that requirement is a ‘reasonable measure[ment] of job performance.” Inclusive Cmtys., 2015 WL 2473449, at *14. Ultimately, in a disparate impact case, a court must distinguish between “artificial, arbitration, and unnecessary barriers,” and reasonable policy choices. Id. at *13.

Is the Court’s departure from the language of the regulation significant? According to the Court, the HUD regulation did not intentionally seek to raise the bar relative to the “business necessity” standard. Instead, HUD found that the phrase “business necessity” was confusing when applied to certain types of entities covered by the FHA, such as nonprofit organizations or public entities, and therefore HUD attempted to rephrase the test without changing its meaning. Inclusive Cmtys., 2015 WL 2473449, at *14.

The HUD policy statement accompanying the promulgation of this rule supports this view. In this policy statement, HUD noted that the phrase “substantial interest” is meant to be “analogous to the Title VII requirement that an employer’s interest in an employment practice with a disparate impact be job related,” the word “legitimate” means “genuine and not false,” and the word “nondiscriminatory” means that the challenge policy or practice “does not itself discriminatory based on a protected characteristic.” See Implementation of the Fair Housing Act’s Discriminatory Effects Standard, Feb. 13, 2013, 78 Fed. Reg. 11460. HUD elaborated that “[t]he ‘’substantial, legitimate, nondiscriminatory interest’ standard found in § 100.500(b)(1) is equivalent to the ‘business necessity’ standard . . .” Id.

At the same time, however, lower courts are likely to encounter cases in which the above-referenced regulatory history offers insufficient guidance, requiring the court to directly interpret the language of the test in accordance with the ordinary meaning of the words that the test employs. In this regard, the Supreme Court’s phrase, “valid interest,” clearly suggests a less onerous burden than HUD’s phrase, “legitimate, substantial, nondiscriminatory.” Indeed, it is telling that the Court appears to be of the view that neither the Inclusive Communities case nor the Magner case would pass muster under the “valid interest” test, in the unlikely event that those claims even survived the first step of the analysis.

The Third Step

The Inclusive Communities decision did not take issue with HUD’s phrasing of the third step of the burden-shifting framework, in which the plaintiff must show, in essence, that the defendant’s justification for the alleged disparate impact is a pretext. However, the Court’s agreement with HUD policy in this regard is important, because some federal courts – including the district court in the Inclusive Communities case – previously had held that this burden fell on the defendant, rather than the plaintiff. Based on the Inclusive Communities decision, placing that burden on the defendant is no longer appropriate.

Conclusion

In many ways, the Supreme Court’s decision is not ground-breaking. The main thrust of the Court’s opinion was to affirm that disparate impact claims are cognizable under the FHA, a view that previously had been adopted by both HUD and every federal court of appeals to address the issue. Moreover, most federal courts already were applying, in most respects, the burden-shifting framework adopted by the Court.

However, the decision also tilts that burden-shifting framework in a way that should be favorable to defendants in disparate impact cases. First, the decision notes that a plaintiff cannot make a prima facie case without showing that the alleged disparate impact is attributable to voluntary policy choices by the defendant. Second, the decision clarifies that a defendant can answer a plaintiff’s prima facie case by identifying a “valid interest” that explains the alleged disparate impact. Third, the decision suggests that a proper application of the burden-shifting framework would have compelled the dismissal of the Magner case and may cast doubt on the viability of the Inclusive Communities case. Fourth, the decision confirms that, once the defendant identifies such a “valid interest,” the burden shifts back to the plaintiff to show that the defendant improperly ignored viable alternatives by means of which the defendant could have achieved its objectives with less discriminatory effect.

As a result, to the extent the decision altered the legal status quo in relation to disparate impact litigation under the FHA, the decision is potentially helpful to defendants. Covered entities should closely follow subsequent decisions as lower courts absorb, and elaborate on, the implications of the decision in the context of disparate impact cases.

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Brent Ylvisaker

Brent Ylvisaker

As an associate in Dorsey’s Finance & Restructuring Group, the types of areas in which he works include: banking regulations (e.g., affiliate transaction rules), consumer financial protection laws, Bank Secrecy Act and anti-money laundering regulations, financial data privacy and protection, state financial laws (including lending license requirements and usury laws) and e-commerce (e.g., E-SIGN and virtual currency).

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