The Supreme Court of California recently upheld the dismissal of negligence claims brought by a borrower in relation to a mortgage servicer’s handling of the borrower’s loan modification application.
In so ruling, the Court held that: (1) consistent with the law in other states, the borrower’s negligence claims here were barred by the economic loss doctrine; and (2) a loan servicer does not owe a borrower a common law duty of care sounding in tort to process, review and respond carefully and completely to the borrower’s loan modification application.
A copy of the opinion in Sheen v. Wells Fargo Bank is available at: Link to Opinion.
The plaintiff borrower (“Borrower”) obtained two loans from the same company (“Lender”) that were secured by his home. After Borrower defaulted on both loans, Lender recorded notices of default in connection with the loans and scheduled a foreclosure sale of the collateral property for February 2010.
Borrower contacted Lender about the possibility of canceling the foreclosure sale in order that Borrower could submit applications for modification of the loans. Borrower submitted his applications in January 2010. Shortly thereafter, Lender canceled the foreclosure sale.
In March 2010, Lender sent Borrower two identical letters, one for each loan, which informed Borrower that the loans had been charged off and accelerated and that Lender would “proceed with whatever action [was] deemed necessary to protect [Lender’s] interests.” Borrower believed the letters meant his loans had been modified to unsecured loans and as a result, the Property would never be sold at a foreclosure auction in connection with those loans. As Lender had not yet responded to Borrower’s modification applications, Borrower believed the letters to be Lender’s response.
In November 2010, one of the loans was sold to another entity (“New Owner”). Four years later, New Owner foreclosed on the Property.
Borrower filed suit against New Owner, Lender, and the entity who acted as servicer at the time of foreclosure (“Servicer”) alleging negligence, promissory estoppel, intentional infliction of emotional distress and violation of the unfair competition law.
Defendants demurred and the trial court granted Lender’s demurrer as to the negligence claim. The Court of Appeals affirmed concluding that relevant authorities “decisively weigh against extending tort duties into mortgage modification negotiations.”
The Supreme Court granted review. The specific question addressed by the Court was whether Lender owed Borrower a duty “to process, review and respond carefully and completely to [his] loan modification applications” so as to avoid causing Borrower pure monetary loss through a negligent lack of care in handling his applications.
Borrower claimed the duty arose as a matter of law upon submission of a loan application to a lender, and that Lender’s failure “to process, review and respond carefully and completely” to the application is actionable in tort. The California Supreme Court noted that the existence of such a duty is an issue upon which the state’s courts of appeal were divided.
“A duty of care may arise through statute” or by operation of the common law. J’Aire Corp. v. Gregory, (1979) 24 Cal.3d 799, 803. The Supreme Court focused its review on the common law, in which Borrower grounded his negligence claim.
The Supreme Court first found Borrower’s argument failed in light of the economic loss doctrine. The economic loss doctrine bars recovery in tort for negligently inflicted “purely economic losses,” or financial harm unaccompanied by physical or property damage. Southern California Gas Leak Cases (2019) 7 Cal. 5th 391, 400. One circumstance in which the economic loss doctrine functions to bar a claim is a negligence claim for pure economic loss in deference to a contract between the parties. See Robinson Helicopter Co., Inc. v. Dana Corp. (2004), 34 Cal.4th 979, 988.
Although not all tort claims for monetary losses between contracting parties are barred by the doctrine, such claims are barred when they arise from the parties’ underlying contracts. See Robinson, 34 Cal.4th at p. 991. The Supreme Court found that Borrower’s claim arose from, and was not independent of, the mortgage loan contract. Thus, the Court held that Borrower’s negligence claim was barred by the economic loss rule.
The Supreme Court noted that the deed of trust entered into by the parties specified their rights and obligations with respect to the loan and the collateral securing the loan. Thus, the Court held, imposing the duty alleged by Borrower would not only create obligations that were not negotiated or agreed to by the parties, but would in fact be contrary to the allocation of rights and responsibilities in the deed of trust. Giving deference to the agreement and according respect to contract doctrines, the Court could not allow a tort duty under these circumstances.
The Supreme Court also noted that its decision is consistent with the decisions of other state supreme courts as well as with the well-established principle of state law that “a financial institution owes no duty of care to a borrower when the institution’s involvement in the loan transaction does not exceed the scope of its conventional role as a mere lender of money. Nymark v. Heart Fed. Savings & Loan Assn. (1991) 231 Cal.App.3d 1089.
Borrower argued that Nymark did not apply because the decision was “limited to the loan origination context.” However, the Court found that the central questions relevant to Nymark’s applicability is whether handling loan modification applications was within the scope of Lender’s role as lender. The Court found that it was. Thus, the Supreme Court found that such involvement, absent more, did not “exceed the scope of [an institution’s] conventional role as a mere lender of money.” Nymark, 231 Cal.App.3d at p. 1096.
The Court further noted that, although some cases involving insurance policies and contracts for professional services allowed tort recovery, these were distinguishable from the mortgage lending and modification cases as they do not share the special characteristics associated with the contexts exempt from the economic loss rule.
Borrower further argued that Nymark and the economic loss rule were not applicable.
Borrower first argued that as he was not claiming a breach of contract, the economic loss doctrine did not apply. However, the Court found the economic loss rule does not apply only when there is a viable breach of contract claim.
Borrower next argued that at the modification stage, borrowers are “captive” as they cannot choose who services their loans or handles their requests for modification. However, the Court found Borrower was only captive to the extent he could not now ask another bank or servicer to rewrite the terms of his contract with Lender. Alvarez v. BAC Home Loans Servicing, L.P. (2014), 228 Cal.App.4th 941, 494.
Borrower also argued that “[i]f the lower Court had considered the [Biakanja v. Irving (1958), 49 Cal.2d 647, 650] factors, it would have seen that they point toward a duty of care in the mortgage servicing context.” However, the Court found that the multifactor approach for ascertaining a duty of care articulated in Biakanja did not apply in the mortgage servicing context as this approach is only applicable when the plaintiff is a “third person not in privity” with the defendant. Biakanja v. Irving (1958), 49 Cal.2d 647, 650. The Supreme Court also held that Biakanja did not displace the contractual economic loss rule when it squarely applied.
Finally, the Court disagreed with Borrower’s arguments that the “policy preventing future harm” (Biakanja, 49 Cal.2d at p. 650) and the “‘“sum total”’” (Goonewardene v. ADP, LLC (2019) 6 Cal.5th 817, 841) of policy considerations required recognition of his claim.
The Court noted that there were viable claims Borrower could bring other than negligence. In addition, the Court found that instead of seeking to fill a gap in the law, Borrower was seeking to create a new and expansive negligence cause of action atop all existing laws. The Court found that imposing such a duty was a policy decision best left to the legislature.
Thus, the Supreme Court held that when a borrower requests a loan modification, the lender owes no tort duty sounding in general negligence principles to “process, review and respond carefully and completely to” the borrower’s application and affirmed the judgment of the lower court.