California Supreme Court Says Lenders Have No Duty of Care in Loan Modification Negotiations
The financial and foreclosure crisis of 2008, in addition to impoverishing a generation of homeowners, led to an explosion of litigation against lenders and loan servicers by aggrieved homeowners. Due to the volume of these cases and the diversity of plaintiffs’ approaches, a division of authority among the various California Court of Appeals districts on a key issue has developed: do lenders have an obligation diligent in reviewing and processing loan modification requests?
On March 7, 2022, in a unanimous and landmark (and whopping 54-page) majority opinion authored by Chief Justice Cantil-Sakauye, the California Supreme Court answered that question with a resounding “no.” In Sheen vs. Wells Fargothe judges considered that “the lender[s] [do not] owe the borrowers a tort based on general principles of negligence. . . ‘process, consider and respond carefully and completely to a borrower’s loan modification request’, so that failure to do so may result in the lender being held liable for the borrower’s debt [solely] economic losses”. (Slip Op. to 2.)
In this case, borrower Kwang Sheen took out second and third mortgages from Wells Fargo on his home in Los Angeles. Sheen eventually missed payments on both loans, and Wells Fargo began foreclosure proceedings, scheduling a trustee sale for February 2010. In January 2010, Sheen, through his representative, contacted Wells Fargo and requested a loan modification in an effort to avoid foreclosure. A week after its request for modification, Wells Fargo canceled the trustee sale scheduled for February. Wells Fargo never responded directly to Sheen about the loan modification requests, but did receive a set of letters relating to the two loans from Wells Fargo in March 2010, which informed it that the loans had been canceled and that the balance had been accelerated. Sheen interpreted these letters to mean that the loans had been changed to become unsecured so that there would be no foreclosure on his property. However, Sheen’s interpretation of the letters turned out to be incorrect, and both loans remained secured as Wells Fargo went to market with the troubled loans.
In November 2010, Wells Fargo sold the second loan to a third party, and that loan ultimately ended up in the hands of Mirabella Investment Group, LLC (“Mirabella”, a client of Gupta Evans & Ayres who prevailed against Sheen on summary judgment, plaintiff’s appeal of which is pending resolution of the Wells Fargo appeal). In 2014, Mirabella foreclosed on the property and it was sold in a foreclosure sale. Sheen’s lawsuit followed, in which he brought causes of action for willful infliction of emotional distress, unfair competition (Section 17200) and, most importantly, negligence. The California Court of Appeals summarily dismissed the emotional distress and unfair competition claims and, in the gist of the opinion, held that Wells Fargo owed no duty of care to Sheen in dealing with her claims. loan modification, relying on the “economic loss rule”. which stipulates that the parties to a contract (or to a negotiation of a contract) do not owe each other not to cause purely economic losses which do not result from the breach of an independent obligation. Sheen vs. Wells Fargo, 38 Cal. App. 5th 346 (2019). In doing so, the Court of Appeal explicitly noted that “[t]The question of whether there is a tort obligation for mortgage modification has divided California courts for years” and that “[t]The California Supreme Court has yet to resolve this division. Identifier. at 348. Picking up the gauntlet, the California Supreme Court granted review.
Like the Court of Appeals, the California Supreme Court used the economic loss rule as its primary justification, which provides that a party to a contract cannot recover in tort for purely economic damages. – “i.e. pecuniary loss not accompanied by material damage or bodily injury” (Slip Op. at 2.) – unless the plaintiff can demonstrate a breach of an obligation arising independently from the contract between the parties . Robinson Helicopter v. Dana Corp., 34 Cal. 4th 979, 992-93 (2004). The court relied heavily on this principle in deciding not to impose an obligation on lenders, noting that the underlying rationale for the rule is to “”prevent the erosion of contractual doctrines by using the law of tort to circumvent them”” (Slip. Op. at 15 (citing Restatement, §3 at p. 2).) The court held that the loan modification is merely a renegotiation of a contract existing, in which the lender tries to find a way to better enforce and protect the rights established by the original contract. (Identifier. at 17-18, 23.)
After noting that his approach was consistent with the majority of other jurisdictions (identifier. 19-22), the court waived the plaintiff’s legal counter-arguments. In particular, the court noted that the economic loss rule is not limited to the granting of the loan, but also to the modification due to its relationship to the original contract between the parties. (Identifier. at 23.) The court also stated that the oft-cited factors of biakanja c. Irving49 Cal.2d 647 (1958)—used to impose a duty of care in certain situations—do not apply when the parties are in a contractual relationship. (Identifier. at age 37.)
Finally, and perhaps most importantly, the court rejected the plaintiff’s political arguments. The court recognized the underlying merits of the plaintiff’s contention that bargaining power in loan modification negotiations is skewed in favor of lenders and managers (who may have incentives to promote foreclosure and to discourage modification), but ultimately said it was the role of the legislature to find the balance between these competing costs and benefits. (Identifier. at 46-55.) The court did not shy away from urging the legislature to act to address the concerns raised by the plaintiff about home loan modification negotiations, stating that “if it chooses, the legislature may both prescribe whether a lender must act “reasonably” and (with some detail, if desired) what constitutes “reasonable” behavior in this area. » (Identifier. at 55.) Judge Liu, in his concurring opinion, was more pointed: “[W]or the mortgage market and affected communities would benefit from manipulative practices and ‘negotiations or information asymmetries’. . . continues to be ripe for legislative scrutiny. (Identifier. at 11 (Liu, J., agrees).) This open signaling from the California Supreme Court could prompt the legislature to act to address the concerns raised by the plaintiff and the court.
The court also apparently reversed precedent to the contrary in a sweeping footnote (identifier. at 55 n.12), but did not delve into the details of previous Court of Appeals cases that found duties of care applicable to lenders. One of the few cases that found a duty of care and on which the plaintiffs relied heavily—Alvarez c. BAC Home Loans Servicing, LP, 228 Cal. App. 4th 941 (2014)– was addressed in the concurring opinion of Judge Jenkins, in which he fell to his sword and referred to his participation in the opinion of this case. In short, Justice Jenkins seemed to concede that he, along with the rest of the majority in Alvarezmisapplied the biakanja factors and overlooked the fact that this analysis only applies when the parties are not bound by a contractual relationship. (Identifier. to 2 (Jenkins, J., concordant).)
In granting review and deciding against the existence of an obligation, the California Supreme Court spoke clearly of the absence of a lender’s obligation to process, review, and respond to loan modification. , thus avoiding a potential instantaneous drastic change in the distribution of risk and liability. between lenders and borrowers. However, at the same time, the Court has also, by asserting its inability to legislate on the subject from the bench, laid the groundwork for possible legislative action. Finally, although the court apparently spoke with the intention of closing the book on this issue in the judicial sphere, given the passing remarks made by concurring judges pointing out points not conclusively resolved by the majority opinion (identifier. at 3-5 (Liu, J. agree); identifier. at 2-3 (Jenkins, J., concurring)), lender litigants can reasonably expect borrower plaintiffs to continue to get their proverbial feet stuck in the door.