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Negligence often seems like the most applicable common law claim for bad servicing and loss mitigation conduct. Most advocates are aware of the long-touted proposition that the lender-borrower relationship is an arms’ length relationship with no elevated duty of care (much less any fiduciary duty). Because of this widely accepted principal, it’s best not to make arguments based on the existence of a fiduciary duty (unless you have very special facts – which will be rare).
But recently, more and more California courts have taken the position that a bank or lender may owe the borrower a duty not to act negligently in handling a loan mod application once it has undertaken to review the application. The premise is that once the bank agrees to review the application, it must review the application up to a reasonable standard of care.
Nymark v. Heart Federal Savings & Loan Association articulated the general rule 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.” The Nymark court when on to state that negligence liability could arise where a lender “‘actively participates’ in the financed enterprise ‘beyond the domain of the usual money lender.’” Under the facts in Nymark, where the borrower complained of a lender using an inaccurate appraisal, the court found that the lender had obtained the appraisal for its own purposes to ensure adequate security for the debt, and had not used the appraisal to “induce plaintiff to enter into the loan transaction or to assure him that his collateral was sound.” Therefore, the lender had not gone beyond its traditional role as a mere lender of money.
Although the lender had not gone exceeded its traditional role, the court still went on to evaluate whether a duty of care might exist based on the six factors identified in Biakanja v. Irving, 49 Cal.2d 647, 650 (1958). These factors will be discussed below.
Of course, lenders have tried to use Nymark’s “general rule” language to imply an across-the-board ban on negligence claims arising out of mortgage lending or servicing.
But California courts have squarely rejected such arguments. Instead, a proper reading of Nymark shows that it allows for the existence of a duty of care, and hence a negligence claim based on the breach of that duty, in either of two scenarios: (1) the lender’s activities went beyond the traditional role of a mere lender of money, such as by exerting undue pressure on a borrower to enter into a loan or being actively involved in the financial enterprise at issue or (2) even where the lender’s activities are “confined to their traditional scope,” a duty may exist depending on a case-by-case analysis of the six factors identified in Biankanja v. Irving.
The six factors courts must analyze in determining whether a lender or servicer owes the borrower a duty of care are as follows:
(1) the extent to which the transaction was intended to affect the plaintiff,
(2) the foreseeability of harm to him,
(3) the degree of certainty that the plaintiff suffered injury,
(4) the closeness of the connection between the defendant’s conduct and the injury suffered,
(5) the moral blame attached to the defendant’s conduct, and
Courts that rule against the borrower on a negligence claim tend to emphasize their conclusion that a loan modification, “which at its core is an attempt by a money lender to salvage a troubled loan, is nothing more than a renegotiation in terms,” is a traditional money lending activity.
The court in Ansanelli disagreed, concluding that the “defendant went beyond its role as a silent lender and loan servicer to offer an opportunity to plaintiffs for loan modification and to engage with them concerning the trial period plan,” and that this was “beyond the domain of a usual money lender.” Still, it is better not to get bogged down with this issue, and instead to focus on the six factors – which, as explained above, the court should apply even when it concludes that the lender was exercising a core money lending function.
A number of courts applying these six factors to wrongful conduct in the review of a loan modification application have found them to weigh solidly in favor of the existence of a duty of care.
For example, In Garcia v. Ocwen Loan Servicing, LLC, Ocwen had received documents from the homeowner in support of his loan modification application but routed them to the wrong department, provided a phone number that went automatically to a recorded message rather than allowing the homeowner to speak with any of its employees, and sold the home at a trustee’s sale while the modification was still under review and without notice to the homeowner.
The court found that at least five out of the six Nymark factors weighed in favor of finding a duty of care. The transaction was “unquestionably intended to affect [the] Plaintiff,” as it “would determine whether or not he could keep his home.” The potential harm to the plaintiff – loss of an opportunity to save his home – was readily foreseeable. In this regard, the court observed, “Although there was no guarantee that the modification would be granted had the loan been properly processed, the mishandling of the documents deprived Plaintiff of the possibility of obtaining the requested relief.”
The injury to the Plaintiff was certain, in that he lost the opportunity to obtain a loan modification and in the process, his home was sold. The court found a close connection between the defendant’s conduct and the injury actually suffered, reasoning that, “to the extent Plaintiff otherwise qualified and would have been granted a modification, Defendant’s conduct in misdirecting the papers submitted by Plaintiff directly precluded the loan modification application from being timely processed.” The court noted that recent actions by the state of California and the federal government (through creating the HAMP program) demonstrated a public policy of preventing future harm to homeowners.
The court declined to decide at this stage of the proceedings whether moral blame attached to the defendant’s conduct, but found that five out of six factors in favor of a duty of care was sufficient to easily tip the scales.
Other courts have analyzed the Biakanja factors and found servicers to owe a duty of care in the loan modification process. In Alvarez v. BAC Home Loans Servicing, LP, the complaint alleged that BAC Home Loans had failed to review the plaintiffs’ loan mod application in a timely manner, foreclosed while a loan modification review was still in process, and mishandled plaintiffs’ applications by relying on incorrect information, such as the wrong figure for monthly income and a false allegation that the second lien holder prevented modification of the loan.In examining the question of whether the defendants’ conduct was blameworthy (the fifth factor), the court found it “highly relevant” that the borrower’s ability to protect his interests in the loan modification process is “practically nil” and the bank “holds all the cards.”
Citing a strong brief from consumer advocates that described the flaws in the modern mortgage servicing system, the court concluded, “The borrower’s lack of bargaining power coupled with conflicts of interest that exist in the modern loan servicing industry provide a moral imperative that those with the controlling hand be required to exercise reasonable care in their dealings with borrowers seeking a loan modification.”
However, plenty of California trial courts have arrived at the opposite conclusion, finding no duty of care in the loan mod process. These courts often seem to get hung up on the fourth factor, the close connection between the servicer’s conduct and the borrower’s injury.
As theLueras court argued, “If the modification was necessary due to the borrower’s inability to repay the loan, the borrower’s harm, suffered from denial of a loan modification, would not be closely connected to the lender’s conduct.” The court further argued regarding the fifth factor that “[i]f the lender did not place the borrower in a position creating a need for a loan modification, then no moral blame would be attached to the lender’s conduct.”
These arguments fundamentally misunderstand the nature and purpose of loss mitigation. Even when a homeowner is in default on the loan because of financial hardship unrelated to the lender’s conduct, the lender’s failure to properly review a loan mod application may be closely connected to the harm of loss of the home if the lender’s failure to review the application properly directly resulted in foreclosure.
In heading off these kinds of arguments, it is helpful to plead (whenever possible) that the borrower was in fact qualified for a loan modification under controlling rules, and that but for the lender’s mishandling of the application, the loan mod would have been approved and foreclosure avoided.
However, the Alvarez and Garcia courts went even further than this, recognizing that even where there was no guarantee a loan modification would have been approved if processed correctly, the servicer’s conduct “deprived Plaintiff of the possibility of obtaining the requested relief.”
Still, in analyzing the close connection factor, the Garcia court also noted that “to the extent Plaintiff otherwise qualified and would have been granted a modification,” the defendant’s conduct had directly prevented the mod from being approved. Therefore, it never hurts to plead eligibility for the modification the plaintiff was seeking.
Although there has been a split of authority from the California Court of Appeals regarding the existence of a duty of care in the handling of loan mod applications, the tide is beginning to turn in favor of homeowners. As one court recently noted, the negative ruling from the Court of Appeals in Lueras v. BAC Home Loans Servicing (2013) relied heavily on the appellate decision in Aspiras v. Wells Fargo Bank, N.A., 219 Cal. App. 4th 948 (2013), which the California Supereme Court recently decertified for publication.
The more recent decision in Alvarez, entered August 7, 2014, represents the most “relevant, recent, and well-reasoned decision on the question.”
The cases where borrowers have been successful on a negligence theory have generally not been based on a theory that the lender was required to approve a loan modification, but rather that the lender had a duty not to mishandle the application. Courts have generally agreed that there is no common law duty to provide a loan modification.
Some of the bad trial court decisions seem to stem from insufficient factual allegations – complaints that rest on generic or conclusory statements of lender failing to “properly service the loan” or to handle the loan “in such a way to prevent foreclosure,” rather than clearly pleading the specific conduct that deprived the plaintiff of the opportunity to be approved for a loan modification for which she was qualified. Other decisions seem to reflect good pleading and simply bad reasoning by the court.
In order to increase the odds of a positive ruling on a negligence claim related to poor servicing, it is important to plead specific facts showing that the lender’s conduct was directly related to the failure to approve your client for a loan modification, that your client in fact qualified for a loan modification under the applicable rules (HAMP, Fannie Mae, Freddie Mac, FHA, etc), and that but for the servicer’s wrongful conduct, your client would have been approved for a modification and would have avoided foreclosure.
It may be worth pleading, in addition or in the alternative, negligence based on the lender’s breach of a duty that comes from RESPA. Such duties would include the duty to exercise reasonable diligence to obtain a complete application, the duty to review a complete application within thirty days, or the duty not to initiate foreclosure when a complete application has been received and is still under review.
Even the Lueras court, which fiercely rejected a homeowner’s negligence claim, recognized that lenders do owe borrowers a duty to “not make material misrepresentations about the status of an application for a loan modification or about the date, time or status of a foreclosure sale.” The court noted that it was completely foreseeable that a borrower might be harmed by “an inaccurate or untimely communication about a foreclosure sale or about the status of a loan modification” and the connection between such a misrepresentation and the harm suffered would be “very close.” The Lueras court explicitly acknowledged the viability of a claim for negligent misrepresentation based on facts such as these. We now turn our attention to these kinds of claims, those based on negligent or fraudulent misrepresentations of fact.
Fraud and Negligent Misrepresentation
Claims for fraud or negligent misrepresentation hinge on a material misrepresentation of fact that causes harm to the plaintiff. In the loss mitigation context, this could include a misrepresentation that a foreclosure sale has been canceled, that a loan modification application has been deemed complete and is under active review, or that a borrower is qualified for a loan modification and should refrain from taking other steps to cure the default and avoid foreclosure.
It makes sense to discuss these two claims together, since the key difference between them is the defendant’s knowledge of falsity and intent to deceive the plaintiff as additional required elements for a fraud claim. It may be a good idea to plead negligent misrepresentation in the alternative whenever raising a fraud claim. After all, even when there is circumstantial evidence of a lender’s bad intent, proving intent can be difficult.
Under California law, the elements of a claim for negligent misrepresentation are:
(1) a misrepresentation of a past or existing material fact, (2) without reasonable grounds for believing it to be true, (3) with intent to induce the plaintiff’s reliance, (4) ignorance of the truth and justifiable reliance by the plaintiff, and (5) damages.
The elements of a claim for fraud are:
(1) the defendant made a false representation as to a past or existing material fact; (2) the defendant knew the representation was false at the time it was made; (3) in making the representation, the defendant intended to deceive the plaintiff; (4) the plaintiff justifiably and reasonably relied on the representation; and (5) the plaintiff suffered resulting damages.
One key detail regarding these claims is that the misrepresentation generally cannot concern a promise to do something in the future; the defendant must have misrepresented a past or existing material fact. At least one court has held that a servicer’s misrepresentations that it would “continue working for a loan modification that would be approved, which would allow Plaintiff to keep and save his home” and other promises related to the terms of the modification which would be approved in the future could not support a claim for negligent misrepresentation.
However, another court reversed a grant of summary judgment to the lender on fraud and negligent misrepresentation claims based on a servicer’s representations that the borrower “should not make the April 2008 loan payment because ‘the worst thing that’s going to happen is you are going to have a late fee, we will get this done for you’; and [ ] her loan modification request likely would be approved because she was prequalified.” These statements seem awfully close to promises regarding future performance, but the court found them sufficient, focusing primarily on the statement that plaintiff should not make the April 2008 payment. This caused her to fall behind on the loan and incur late fees, and she testified that she could have caught up the missed payments prior to the foreclosure date – just not these additional fees.
The complaint also must provide factual support for the assertion that statements at issue were misrepresentations of fact, rather than merely concluding that the representations were false.
Another difficult element of these claims is showing that the plaintiff justifiably relied on the misrepresentations.
Justifiable reliance may be refuted if the lender can point to evidence that should have aroused suspicion or disbelief in the plaintiff regarding the accuracy of the misrepresentations. For example, one court found a lack of justifiable reliance on statements that her loan was “in underwriting” and “under review” and thus a foreclosure would not proceed where the complaint also contained allegations that the application had been denied prior to foreclosure, the file was closed, and the plaintiff had “actual knowledge” of the scheduled foreclosure sale.
The court found that these alleged facts rendered it unjustifiable for plaintiff to forego taking the actions “she deemed necessary to avoid the foreclosure sale” because the plaintiff “was on notice of problems to frustrate the notion of her justifiable reliance.” 
Finally, another challenge to these types of claims is the heightened pleading standard of Federal Rule of Civil Procedure 9(b). Recall that these claims must be pled with particularity, not just plausibility. One example of this is that in a fraud claim against a corporation, a plaintiff must “allege the names of the persons who made the allegedly fraudulent representations, their authority to speak, to whom they spoke, what they said or wrote, and when it was said or written.”