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Calif. App. Court (3rd Dist) Allows HOBR Claim for Vague Reasons for Loan Mod Denial

The Court of Appeal for the Third District of California recently affirmed in part, and reversed in part, an order granting a mortgage servicer’s motion to dismiss several causes of action brought by plaintiff borrowers for denying their requests to modify their mortgage loan.

The appellate court affirmed the dismissal as to the borrowers’ counts for breach of contract, negligence, and intentional infliction of emotional distress.  However, it also held that the borrowers stated a valid cause of action under California’s Homeowner Bill of Rights, section 2923.6, and reversed as to that claim.

Specifically, the appellate court concluded that the servicer’s explanation that it “do[es] not have the contractual authority to modify [the] loan because of limitations in [its] servicing agreement” was not sufficiently detailed, and that without knowing the actual reason for denial, it could not be said for certain that the failure to provide “specific reasons for the investor disallowance” as required under section 2923.6(f) was not material.

A copy of the opinion in Potocki v. Wells Fargo Bank, N.A. is available at:  Link to Opinion.

After falling behind on their mortgage loan, the plaintiffs-borrowers requested loss mitigation assistance from their mortgage servicer and alleged that they were offered a loan modification in exchange for agreeing to make three trial payments of $1,633.53.  The borrowers completed the trial payments but were not offered a modification, which led to the servicer recording a notice of default three months later.  After first dismissing an action against the servicer without prejudice, the borrowers initiated the instant litigation in early 2014.

In late 2014, the borrowers submitted a completed loan modification application with supporting documents to the servicer to review the borrowers for a Home Affordable Modification Program (HAMP) or a non-Hamp “Trial Payment Plan” modification.  Two months later, the servicer denied the borrowers for the HAMP modification, purportedly due to lack of contractual authority to modify the loan due to limitations in its servicing agreement.  However, the borrowers were provided a non-Hamp Trial Payment Plan offer that required them to make three trial payments—the first one in the amount of $171,745.78—which was “essentially an initial payment of the past due total arrearages.”

The borrowers appealed the servicer’s denials, arguing that the non-Hamp Trial Payment Plan was a constructive denial and that they would have been approved if “fairly and carefully reviewed.”

The borrowers’ operative third amended complaint alleged five causes of action against the servicer for: (1) breach of contract, (2) violation of California’s Business & Professions Code section 17200 (not at issue on appeal), (3) negligence, (4) violation of California’s Homeowner Bill of Rights, section 2923.6, and (5) intentional infliction of emotional distress.

As was the case with the prior complaints, the trial court sustained the servicer’s demurrer to the third amended complaint as to all causes of action, and this time, without leave to amend.  The instant appeal from the judgment of dismissal followed.

Initially, the Third District reviewed the borrowers’ breach of contract claim, which alleged that the servicer had breached the written contract to extend a mortgage modification in exchange for three trial payments.

The appellate court noted that the purported contract attached to the third amended complaint referred multiple times to the agreement the servicer offered as a “Special Forbearance Agreement,” and expressly stated that it was “not a waiver of the accrued or future payments that become due, but a period for you to determine how you will be able to resolve your financial hardship.”  Further, the purported “agreement” made no promise of a loan modification, but that “[t]he lender is under no obligation to enter into any further agreement,” and completion of trial payments would result only in a review for a loan modification based on investor approval.

The borrowers’ argument that the temporary payment plan, which led them to believe a permanent modification was forthcoming, was tantamount to a binding contract was rejected by the trial court.  On appeal, they argued that the trial court erred in finding that the forbearance agreement did not obligate the servicer to modify their mortgage loan, citing the 4th District’s holding in West v. JPMorgan Chase Bank, N.A., (2013) 214 Cal.App.4th 780, which held a “Trial Plan Agreement” required the lender to offer a permanent loan modification.

The Third District similarly found the borrowers’ argument unconvincing, and distinguished the facts from West, which offered a modification under HAMP, for the case at bar, which expressly disclaimed a promise to modify.  Whereas West was grounded in a Treasury directive and HAMP guidelines, the forbearance agreement here offered no comparable authority for imposing a similar obligation upon the servicer.  Accordingly, the appellate court concluded that the servicer’s demurrer was properly sustained as to their breach of contract claim.

The borrowers’ negligence claim argued that the servicer owed them a general duty of care in the handling and processing of their loss mitigation review and negligently made false representations in promising a modification in exchange for trial payments.

While acknowledging that a financial institution can owe a duty of reasonable care in processing loan modifications (Alvarez v. BAC Home Loans Servicing, LP, (2014) 228 Cal.App.4th 941), the trial court sustained the servicer’s demurrer as to this count on the basis that the borrowers merely alleged that a nonexistent contract was not honored, and the claim for negligence per se similarly failed for failure to reference any such violation.

On appeal, the borrowers argued that the trial court failed to “adequately apply” Alvarez, and that a per se duty of care is also owed under California’s Homeowner Bill of Rights.  The appellate court disagreed.

Even assuming that the servicer owed a duty of care in processing the loan application, the Third District held that the borrowers’ third amended complaint failed to allege a breach or any facts that might suggest a failure to comply with any duty under Alvarez.  Thus, the trial court’s decision to sustain the servicer’s demurrer as to the borrower’s negligence claim was affirmed.

Next, the appellate court reviewed the dismissal of the borrowers’ cause of action under California’s Homeowner Bill of Rights.  In sustaining the servicer’s demurrer, the trial court rejected the borrowers’ claims that their written denials were insufficiently detailed to comply with section 2923.6(f) on the basis that the borrowers’ allegations were vague and they failed to provide authority that anything more was required.

As you may recall, Section 2923.6 subdivision (f) of the Homeowner Bill of Rights requires a servicer, following the denial of a loan modification, to send written notice “identifying the reasons for the denial.”  Subdivision (f)(2) further requires that “[i]f the denial was based on investor disallowance, the specific reasons for the investor disallowance” must be given.  (§ 2923.6, subd. (f)(2)).

On appeal, the Third District analyzed the servicer’s denial for a HAMP modification, which explained that “[we] do not have the contractual authority to modify your loan because of limitations in our servicing agreement.”  The appellate court concluded that the statement was ambiguous and did not suffice as an explanation – at least for the purposes of a demurrer.

Although the servicer argued that the purported violation was not material, as is required for a borrower to bring a claim for injunctive relief under section 2923.6 when a deed upon sale has not yet been recorded, the appellate court disagreed, reasoning that it could not determine whether the failure to provide “reasons for the disallowance” was not material without knowing the investor’s actual reason for denying the HAMP modification.

Because the appellate court concluded that the borrowers stated a claim under section 2923.6, the trial court’s order sustaining the demurrer to the Homeowner Bill of Rights claim was reversed.

Lastly, the Third District reviewed the sustained demurrer as to the borrowers’ intentional infliction of emotional distress claim—that the servicer’s refusal to provide a modification and offer approving modification conditioned only upon payment of $171,745.78 in arrearages constituted “extreme and outrageous” conduct.

In sustaining the demurrer, the trial court explained that creditors, such as the servicer, enjoy a qualified privilege to protect their economic interest by asserting their legal rights—in this instance, to collect the six-plus years of arrearages due on the loan—even though doing so may cause emotional distress.

On appeal, the borrowers argued that the trial court failed to adequately consider cases finding actionable conduct based on improper creditor action.  Bundren v. Superior Court, (1983) 145 Cal.App.3d 784, 790 (creditor who knows the debtor is susceptible to emotional distress due to a physical or mental condition may incur liability for causing emotional distress). The borrowers claim that the servicer knew its conduct was likely to cause more emotional distress than a typical debt collection because it knew they were trying to modify their loan since 2010 and could become homeless.

While acknowledging that the Bundren court held that creditors could lose their qualified privilege to protect their economic interest if outrageous and unreasonable means are used to seek payment, the appellate court found no such conduct occurred here which “exceed[ed] all bounds usually tolerated by decent society, of a nature which is especially calculated to cause, and does cause, mental distress of a very serious kind.” ’ ” (Christensen v. Superior Court, (1991) 54 Cal.3d 868, 904–905.).  Thus, the demurrer was sustained as to the borrowers’ claims for intentional infliction of emotional distress.

For all of the foregoing reasons, the Third District reversed the trial court’s order sustaining the demurrer as to the borrowers’ claims under the Homeowner Bill of Rights, but affirmed as to all other counts, and remanded to the trial court for proceedings consistent with the appellate court’s opinion.

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Christopher P. Hahn practices in Maurice Wutscher’s Commercial Litigation, Consumer Credit Litigation and Insurance Recovery and Advisory groups. Prior to joining Maurice Wutscher LLP, he served under the General Counsel at the Florida Office of Financial Regulation. He also obtained extensive experience litigating property insurance claims through all phases of discovery, motion practice and other pre-trial activities. Christopher obtained his Bachelor of Science degree in Business Administration from the University of Southern California, followed by his Juris Doctorate degree from the University of Miami School of Law. He is also a graduate of the University of Miami’s Masters of Business Administration program, completing his degree with an emphasis on finance and mergers and acquisitions.

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