California Supreme Court rules on negligence claims related to mortgage modifications | Snell and Wilmer
On March 7, the California Supreme Court settled the issue of whether a mortgage servicer owed a duty of care to a borrower in a loan modification review, finding that negligence claims related to the modification of a loan were prohibited by the doctrine of economic loss and that there was no particular relationship between a lender and a borrower that would give rise to an obligation.
In California, the general rule has always been that “a financial institution owes no duty of care to a borrower when the institution’s involvement in the lending transaction does not exceed the scope of its conventional role as mere money lender”.1 For many years, the courts interpreted this rule to include loan modification review activities because these were part of a typical lender-borrower relationship.
In 2013, the First Appellate District questioned the application of the Nymark rule to a home building loan deal.2 While acknowledging that Nymark was the general rule and that the plaintiff had alleged no special relationship or fiduciary duty, the court applied a six-factor test first articulated in Biakanja v. Irving.3 Apply the biakanja4 factors, the court found that the lender breached its duty by failing to consider the plaintiff in good faith for a loan modification. In 2014, the First Appellate District again reaffirmed its position by finding that a lender had a duty of care when reviewing a borrower for loan modification.
Meanwhile, the second appellate district came to the opposite conclusion the same year.5 In Luerasthe court specifically dismissed Jolley and held that “a loan modification is a renegotiation of the terms of the loan, which falls squarely within the lending institution’s conventional role as a lender of money”.6 In coming to this conclusion, the court analyzed the extensive case law that had applied the Nymark rule and the Biakanja factors and concluded that there was no obligation.
The recent decision of the Supreme Court of California in Sheen vs. Wells Fargo Bank, NA now resolves this conflict.7 In Glowthe Court ruled that the biakanja factors did not “provide a convincing basis for recognizing such an obligation”.8 Instead, the Court held that the relationship between a lender and a borrower is governed by the contracts between them – the note and the trust deed – and therefore a negligence claim would be barred by the doctrine of economic loss. Identifier. The Court stated that “there are good reasons to adhere to the economic loss rule in this case, given the nature of the parties’ contractual relationship and the way in which that relationship could be disrupted by the acknowledgment of the applicant’s advances” – the obligation to “deal, consider and respond carefully and completely to [a borrower’s] loan modification request. Identifier.
While the Court’s decision settles the question of whether a lender owes a duty of care to the borrower in the context of the loan modification, the Court specifically declined to rule on the borrower’s related claims for negligent misrepresentation and promissory estoppel. While we will likely see a decline in negligence claims in the context of loan modification, lenders and financial institutions should anticipate that borrowers will continue to assert further claims against them in this context.